The 1000 largest non-financial companies in the U.S. significantly improved their ability to generate cash in 2017, producing the strongest working capital performance since 2008. However, their ability to collect from customers and manage inventory actually both deteriorated, masked by a significant increase in the time companies take to pay suppliers, according to the latest Working Capital Survey results from The Hackett Group.
In 2017, companies significantly extended payments to suppliers, taking 3.4 days longer to pay than in 2016 and improving Days Payable Outstanding (DPO) by increasing it to 56.7 days. Increasing DPO keeps cash on the balance sheet longer and improves cash position.
The survey found evidence that for many companies, improving DPO involves companies simply pushing the working capital burden onto their suppliers, including much smaller companies, by forcing them to accept longer payment terms. Supply chain financing is also growing in popularity as a way to improve DPO performance while limiting the impact on suppliers.
Performance of the other major elements of working capital performance, receivables and inventory, both deteriorated slightly in 2017. Days Sales Outstanding (DSO) rose by 4.4% to 39.5 days and Days Inventory On hand (DIO) rose by just 0.6% to 51 days.
Overall, the survey found the companies had a Cash Conversion Cycle (CCC) of 33.8 days, an improvement of 1.5 days (4%) over last year. This is a significant improvement over the high CCC of 37.3 days seen in 2015, and nearly matches the lowest recent CCC of 33.4 days seen in 2008, which was driven largely in changes made in response to the recession. CCC is a standard metric used to quantify the ability of companies to convert invested resources into cash, and incorporates payables, receivables and inventory.
Top performers by industry in the survey are now nearly three times faster than typical companies at converting working capital into cash (16.7 days for top quartile companies versus 47.5 days for typical).
They collect from customers 2.7 weeks faster (29.1 days vs 47.7), pay suppliers three weeks slower (66.9 days vs 45.4) and hold less than half the inventory (23.9 days vs 57.7).
This translates into a $1.1 trillion improvement opportunity for companies that are not top performers, an amount equal to nearly 6% of the U.S. Gross Domestic Product.
Inventory remains the largest opportunity ($443 billion). However, for 2017 the opportunity in payables ($358 billion) grew larger than the opportunity in receivables ($334 billion).
Despite the strong overall working capital performance of companies in the survey, the opportunity gap between typical companies and top performers continues to grow, indicating that top performers are highly focused on generating improvements in this area, while many typical companies are neglecting working capital improvement.
Interest Rates
Rising interest rates and extremely high M&A activity were two major factors impacting on U.S. working capital performance in 2017. Tax reform and continued reliance on cheap debt helped drive cash on hand up 17%, to its highest level ever ($1.07 trillion), while debt rose by nearly 10% (to $5.6 trillion).
Despite rising interest rates, companies are continuing to leverage debt, in many cases to fund acquisitions. Debt as a percentage of revenue has continued to climb, reaching 51% of revenue in 2017, steadily increasing over the last few years from closer to 33% revenue for the period 2008-2013.
Capital expenditures also increased by 5.5%, the first increase since 2014, indicating that companies may be shifting towards investing in themselves, rather than continuing to focus on returning cash to shareholders, as they have since the financial crisis.
“For the first time in years we’re finally seeing rising interest rates, and that is driving more companies to look at improvements to working capital,” said The Hackett Group Associate Principal Craig Bailey. “The record level of M&A is also starting to increase the focus on both cost and cash. So we’re seeing a significant improvement in working capital performance. But debt is also reaching record levels, and despite the improvements, it appears clear that most companies are still looking for quick fixes and avoiding doing the process improvement and other hard work required to truly improve working capital.”
“The primary strategy many companies are using to improve working capital performance is simply to hold back payments to suppliers, in some cases extending payment terms up to 120 days,” said Bailey. “Payables are often the easiest starting point for working capital improvement, as the processes are largely in finance’s area of control, and it has less risk of impacting on customers. Unfortunately, when companies extend payment terms it has significant impact on the DSO performance of their suppliers. This year it is driving DSO to a 10-year high. It can even destabilize a supply base, if companies are not careful.”
“Another increasingly popular way companies are improving payables performance is through supply chain financing,” explained Bailey. “But it’s truly not the best way to improve overall working capital performance, as it basically enables companies to avoid dealing with process inefficiency by using a bank to offer suppliers financing of their receivables.”
“The focus on slowing payments to suppliers also significantly drives the burden of working capital performance onto smaller companies, most of which are below the radar of our survey. Many smaller companies, and also other companies that cannot easily improve their payables performance, such as those with consolidated supply bases, or those with a multitude of small suppliers, are struggling,” said Bailey.
According to The Hackett Group Director Shawn Townsend, “Even just in terms of payables optimization, there are better ways to make improvements than to delay supplier payments. Some companies understand this, which is why despite improved overall working capital performance, the opportunity gap between typical companies and top performers continues to increase. Some organizations show what can truly be accomplished, while many others avoid dealing with the underlying issues.”
“There are simply much better options available. For example, companies can focus on differentiating critical from non-critical suppliers. They can strive to improve the procure-to-pay cycle without impacting supply base, through process improvement, digitization, robotic process automation, blockchain, and other digital transformation approaches,” said Townsend.
